The invisible green hand

Markets could be a potent force for greenery—if only greens could learn to love them

“MANDATE, regulate and litigate.” That has been the environmentalists' rallying cry for ages. Nowhere in the green manifesto has there been much mention of the market. And, oddly, it was market-minded America that led the dirigiste trend. Three decades ago, Congress passed a sequence of laws, including the Clean Air Act, which set lofty goals and generally set rigid technological standards. Much of the world followed America's lead.

This top-down approach to greenery has long been a point of pride for groups such as the Natural Resources Defence Council (NRDC), one of America's most influential environmental outfits. And with some reason, for it has had its successes: the air and water in the developed world is undoubtedly cleaner than it was three decades ago, even though the rich world's economies have grown by leaps and bounds. This has convinced such groups stoutly to defend the green status quo.

But times may be changing. Gus Speth, now head of Yale University's environment school and formerly head of the World Resources Institute and the UNDP, as well as one of the founders of the NRDC, recently explained how he was converted to market economics: “Thirty years ago, the economists at Resources for the Future were pushing the idea of pollution taxes. We lawyers at NRDC thought they were nuts, and feared that they would derail command-and-control measures like the Clean Air Act, so we opposed them. Looking back, I'd have to say this was the single biggest failure in environmental management—not getting the prices right.”

A remarkable mea culpa; but in truth, the command-and-control approach was never as successful as its advocates claimed. For example, although it has cleaned up the air and water in rich countries, it has notably failed in dealing with waste management, hazardous emissions and fisheries depletion. Also, the gains achieved have come at a needlessly high price. That is because technology mandates and bureaucratic edicts stifle innovation and ignore local realities, such as varying costs of abatement. They also fail to use cost-benefit analysis to judge trade-offs.

Command-and-control methods will also be ill-suited to the problems of the future, which are getting trickier. One reason is that the obvious issues—like dirty air and water—have been tackled already. Another is increasing technological complexity: future problems are more likely to involve subtle linkages—like those involved in ozone depletion and global warming—that will require sophisticated responses. The most important factor may be society's ever-rising expectations: as countries grow wealthier, their people start clamouring for an ever-cleaner environment. But because the cheap and simple things have been done, that is proving increasingly expensive. Hence the greens' new interest in the market.

Carrots, not just sticks

In recent years, market-based greenery has taken off in several ways. With emissions trading, officials decide on a pollution target and then allocate tradable credits to companies based on that target. Those that find it expensive to cut emissions can buy credits from those that find it cheaper, so the target is achieved at the minimum cost and disruption.

The greatest green success story of the past decade is probably America's innovative scheme to cut emissions of sulphur dioxide (SO2). Dan Dudek of Environmental Defence, a most unusual green group, and his market-minded colleagues persuaded the elder George Bush to agree to an amendment to the sacred Clean Air Act that would introduce an emissions-trading system to achieve sharp cuts in SO2. At the time, this was hugely controversial: America's power industry insisted the cuts were prohibitively costly, while nearly every other green group decried the measure as a sham. In the event, ED has been vindicated. America's scheme has surpassed its initial objectives, and at far lower cost than expected. So great is the interest worldwide in trading that ED is now advising groups ranging from hard-nosed oilmen at BP to bureaucrats in China and Russia.

Europe, meanwhile, is forging ahead with another sort of market-based instrument: pollution taxes. The idea is to levy charges on goods and services so that their price reflects their “externalities”—jargon for how much harm they do to the environment and human health. Sweden introduced a sulphur tax a decade ago, and found that the sulphur content of fuels dropped 50% below legal requirements.

Though “tax” still remains a dirty word in America, other parts of the world are beginning to embrace green tax reform by shifting taxes from employment to pollution. Robert Williams of Princeton University has looked at energy use (especially the terrible effects on health of particulate pollution) and concluded that such externalities are comparable in size to the direct economic costs of producing that energy.

Externalities are only half the battle in fixing market distortions. The other half involves scrapping environmentally harmful subsidies. These range from prices below market levels for electricity and water to shameless cash handouts for industries such as coal. The boffins at the OECD reckon that stripping away harmful subsidies, along with introducing taxes on carbon-based fuels and chemicals use, would result in dramatically lower emissions by 2020 than current policies would be able to achieve. If the revenues raised were then used to reduce other taxes, the cost of these virtuous policies would be less than 1% of the OECD's economic output in 2020.

Such subsidies are nothing short of perverse, in the words of Norman Myers of Oxford University. They do double damage, by distorting markets and by encouraging behaviour that harms the environment. Development banks say such subsidies add up to $700 billion a year, but Mr Myers reckons the true sum is closer to $2 trillion a year. Moreover, the numbers do not fully reflect the harm done. For example, EU countries subsidise their fishing fleets to the tune of $1 billion a year, but that has encouraged enough overfishing to drive many North Atlantic fishing grounds to near-collapse.

Fishing is an example of the “tragedy of the commons”, which pops up frequently in the environmental debate. A resource such as the ocean is common to many, but an individual “free rider” can benefit from plundering that commons or dumping waste into it, knowing that the costs of his actions will probably be distributed among many neighbours. In the case of shared fishing grounds, the absence of individual ownership drives each fisherman to snatch as many fish as he can—to the detriment of all.

Of rights and wrongs

Assigning property rights can help, because providing secure rights (set at a sustainable level) aligns the interests of the individual with the wider good of preserving nature. This is what sceptical conservationists have observed in New Zealand and Iceland, where schemes for tradable quotas have helped revive fishing stocks. Similar rights-based approaches have led to revivals in stocks of African elephants in southern Africa, for example, where the authorities stress property rights and private conservation.

All this talk of property rights and markets makes many mainstream environmentalists nervous. Carl Pope, the boss of the Sierra Club, one of America's biggest green groups, does not reject market forces out of hand, but expresses deep scepticism about their scope. Pointing to the difficult problem of climate change, he asks: “Who has property rights over the commons?”

Even so, some greens have become converts. Achim Steiner of the IUCN reckons that the only way forward is rights-based conservation, allowing poor people “sustainable use” of their local environment. Paul Faeth of the World Resources Institute goes further. He says he is convinced that market forces could deliver that holy grail of environmentalism, sustainability—“but only if we get prices right.”

The limits to markets

Economic liberals argue that the market itself is the greatest price-discovery mechanism known to man. Allow it to function freely and without government meddling, goes the argument, and prices are discovered and internalised automatically. Jerry Taylor of the Cato Institute, a libertarian think-tank, insists that “The world today is already sustainable—except those parts where western capitalism doesn't exist.” He notes that countries that have relied on central planning, such as the Soviet Union, China and India, have invariably misallocated investment, stifled innovation and fouled their environment far more than the prosperous market economies of the world have done.

All true. Even so, markets are currently not very good at valuing environmental goods. Noble attempts are under way to help them do better. For example, the Katoomba Group, a collection of financial and energy companies that have linked up with environmental outfits, is trying to speed the development of markets for some of forestry's ignored “co-benefits” such as carbon storage and watershed management, thereby producing new revenue flows for forest owners. This approach shows promise: water consumers ranging from officials in New York city to private hydro-electric operators in Costa Rica are now paying people upstream to manage their forests and agricultural land better. Paying for greenery upstream turns out to be cheaper than cleaning up water downstream after it has been fouled.

Economists too are getting into the game of helping capitalism “get prices right.” The World Bank's Ian Johnson argues that conventional economic measures such as gross domestic product are not measuring wealth creation properly because they ignore the effects of environmental degradation. He points to the positive contribution to China's GDP from the logging industry, arguing that such a calculation completely ignores the billions of dollars-worth of damage from devastating floods caused by over-logging. He advocates a more comprehensive measure the Bank is working on, dubbed “genuine GDP”, that tries (imperfectly, he accepts) to measure depletion of natural resources.

That could make a dramatic difference to how the welfare of the poor is assessed. Using conventional market measures, nearly the whole of the developing world save Africa has grown wealthier in the past couple of decades. But when the degradation of nature is properly accounted for, argues Mr Dasgupta at Cambridge, the countries of Africa and south Asia are actually much worse off today than they were a few decades ago—and even China, whose economic “miracle” has been much trumpeted, comes out barely ahead.

The explanation, he reckons, lies in a particularly perverse form of market distortion: “Countries that are exporting resource-based products (often among the poorest) may be subsidising the consumption of countries that are doing the importing (often among the richest).” As evidence, he points to the common practice in poor countries of encouraging resource extraction. Whether through licences granted at below-market rates, heavily subsidised exports or corrupt officials tolerating illegal exploitation, he reckons the result is the same: “The cruel paradox we face may well be that contemporary economic development is unsustainable in poor countries because it is sustainable in rich countries.”

One does not have to agree with Mr Dasgupta's conclusion to acknowledge that markets have their limits. That should not dissuade the world from attempting to get prices right—or at least to stop getting them so wrong. For grotesque subsidies, the direction of change should be obvious. In other areas, the market itself may not provide enough information to value nature adequately. This is true of threats to essential assets, such as nature's ability to absorb and “recycle” CO2, that have no substitute at any price. That is when governments must step in, ensuring that an informed public debate takes place.

Robert Stavins of Harvard University argues that the thorny notion of sustainable development can be reduced to two simple ideas: efficiency and intergenerational equity. The first is about making the economic pie as large as possible; he reckons that economists are well equipped to handle it, and that market-based policies can be used to achieve it. On the second (the subject of the next section), he is convinced that markets must yield to public discourse and government policy: “Markets can be efficient, but nobody ever said they're fair. The question is, what do we owe the future?”